House conveyancers are adding one more bit of indemnity insurance to some house purchasers’ bills – and it looks as if “gifted deposit indemnity insurance” is of no use except to the insurers who sell it.
Add it to the list of various types of indemnity insurance for chancel repairs; for failure of a previous owner to gain planning permission; for a previous owner breaching restrictive covenants; indemnity for various other legal costs. Some of these products are of dubious value – but a new study suggests gifted deposit indemnity insurance – used (at the homebuyer’s expense) to protect banks if someone giving a gift towards a home purchase goes bankrupt – has no real function at all.
The issue is increasingly significant as more and more parents are giving financial help for their children’s home purchases. The insurance is paid for by the home buyer, intended to protect the mortgage provider, but in reality would only kick in if the conveyancers weren’t doing their job properly or the bank itself was acting in bad faith. Arguably that means it actually has no real purpose at all.
The principle behind the insurance is that it protects the mortgagee’s (ie bank lending the money) title in the property if the donor of a gift or informal family loan goes bankrupt and creditors make a claim to the money as part of the donor’s assets. Buyers are said to feel pressured into buying the insurance, costing up to £300, even though they don’t understand it.
But is it strictly necessary? There is strong evidence that conveyancers are the ones who don’t understand the law and that the insurance is for the most part unnecessary – even when “bank of mum and dad” does go belly-up.
The conveyancer’s job is to ensure the mortgagor (homebuyer) and the mortgagee (bank) obtain “a good and marketable title to the property and free from prior mortgages or charges and from onerous encumbrances which title will be registered with absolute title” (Solicitors’ Regulation Authority Handbook). This will include checking the bona fides of the donor. With all checks done the conveyancer provides a certificate of title to the lender (ie the bank/mortgagee).
If parents give a gift or informal loan for a home purchase, they potentially gain a property interest in the home. The insurance, on the face of it, protects against the donor’s bankruptcy since creditors could put the home purchaser’s and bank’s title in the property at risk and threaten the mortgage company’s security.
Why? Because Section 339 of the Insolvency Act 1986 says that if a bankrupt has within the previous five years “entered into a transaction with any person at an undervalue,” then “the trustee of the bankrupt’s estate may apply to the court for an order” to restore the gift to the donor – hence allowing creditors to get hold of it.
The relevant definition of “at an undervalue” is at subsection (3)(a): “he makes a gift to that person or he otherwise enters into a transaction with that person on terms that provide for him to receive no consideration”. So a loan or gift from a parent to a child to help in a home purchase would be a transaction at an undervalue – since the parent is unlikely to demand a commercial rate of interest on a loan or some “valuable consideration” in return for the gift. The asset to be returned to the donor is now not money but a property interest in the home of the son or daughter. So this would be available to the creditors – putting the title that the mortgagee and mortgagor (bank lender and home-buyer) have in the property at risk.
However, another provision in the 1986 Act protects the mortgagee from this risk. Section 342(2)(a) says such an order “shall not prejudice any interest in property which was acquired from a person other than that individual and was acquired in good faith and for value, or prejudice any interest deriving from such an interest”. The “good faith” bit is important. The effect is that the bank is protected from a Section 339 order by S.342 as long as it acts honestly and doesn’t knowingly aid dishonesty. Its title in the property is protected.
Yet legal academic Nick Piška points out in a new piece in The Conveyancer and Property Lawyer*: “it has come to my attention that a number of conveyancers ask for indemnity insurance as a matter of course when they have notice of a gifted deposit” – even though S.342 applies. This he calls “a gift to the insurance industry”. He notes:
“The purchaser is not in a strong position to refuse such indemnity insurance: they will be told it is required by the bank and, not wanting to jeopardise the purchase of possibly their first property, they will often pay for it with little likelihood it will ever be needed.”
If gifts are given towards purchase, banks are likely anyway to have already insisted the donor sign gifted deposit forms, in effect postponing any possible interest the donor has in the property to that of the bank. These forms indicate a loan has no interest requirement and gives rise to no title in the property or that a gift is unconditional and non-refundable. Even these are probably unnecessary given the provisions of the Land Registration Act 2002 ensuring the mortgagee has priority over any claim that the donor may have for the return of the gift.
Gifts made two years before presentation of a bankruptcy petition against a donor can be set aside upon bankruptcy of the donor irrespective of whether s/he was insolvent when giving the gift. Between two and five years, Section 339 applies only if the donor was insolvent at the time of the gift or as a result of giving it. There is a rebuttable presumption that the donor is insolvent where the gift is to an “associate” – including relatives. The presumption is to cover cases where a donor tries to put assets beyond the reach of creditors.
A bankruptcy order can draw the gift back to the donor and thence to the creditors, to the detriment of the donee/mortgagor (the purchase could be set aside), who has no equitable claim to the money since s/he is a “volunteer” – someone who did not offer valuable consideration in return for the gift. But a mortgagee (bank) can resist the order on the basis of the traditional defence of the “bona fide purchaser for value without notice (of another’s claim on the property)” – making the mortgagee the equivalent of “equity’s darling” (one with an unassailable claim in equity).
Although a mortgagee does have notice of the gift, Section 342(2)(a) has removed “without notice” from the traditional wording (in an amendment in the Insolvency (No.2) Act 1994) – giving protection to the mortgagee’s interest in the home. Problems would only occur if the bank knew both that there was a gift/transaction at an undervalue and that the donor was already insolvent or a petition of bankruptcy had been presented when the gift was made. Amendments in the 1994 Act were specifically intended to protect third party purchasers (which is in effect what the mortgagee is) and obviate the need for what could be very expensive indemnity insurance. So Lord Coleraine said at the time of the passage of the legislation:
“the saving in that section [of the Insolvency Act] for a third party purchaser for value and in good faith will no longer be negatived merely by the purchaser’s knowledge of an earlier transaction at an undervalue or preference … the effect of the clause should be to speed conveyancing and greatly reduce the need for insurance in the cases where problems arise” (Hansard 1994 vol 554 at para 348).
The insurance would theoretically only pay out if the bank behaved in bad faith, knowingly allowing an attempt to put the donor’s funds beyond creditors for instance. So, actually it is difficult to see how it would ever pay out.
Piška concludes that indemnity insurance is therefore “unnecessary as long as the bank has acted ‘in good faith’ in its dealings” – meaning honest behaviour without ulterior motives. The implication is that, although the insurance is intended to protect the bank’s interest, in reality it is used to shield conveyancers from negligence claims by the bank where the conveyancers have failed to do the right bankruptcy checks. It is not really insurance against a donor going bankrupt but against professionals not doing their jobs properly. Piška notes:
“As long as the third party purchaser [mortgage bank] can show it acted honestly and without ulterior motives then it will be able to avail itself of the good faith defence.”
So as long as the bank ensures that the conveyancer has made the bankruptcy checks regarding any gifted deposit, the bank will have acted in good faith. A bank might face difficulties only if it knew of any malpractice in the deal or an attempt to avoid creditors by handing a gift to the donee. But even this might not be decisive in establishing bad faith, according to Piška.
And anyway, judges have some discretion in S.339 orders and would be unlikely to set aside a donee’s title to the property on the basis of a relatively small gift from a parent. If a donor did become bankrupt “it seems unlikely that the court would make an order under s.339 transferring the donee’s title to the property to the trustee in bankruptcy or setting aside a bank’s charge,” says Piška. “The most one would expect would be an order that the donee pay an equivalent amount to the trustee in bankruptcy, perhaps secured by way of an equitable lien on the property.”
If the gift was given specifically to put it beyond the reach of creditors, an order could be made under Sections 423–425 of the Insolvency Act to restore the position to that before the transaction at an undervalue. Section 425 would protect the bank if its interest was “acquired in good faith, for value and without notice of the relevant circumstances”. This, of course, does not exclude the words “without notice” – but this does not matter unless the bank was aware of the donor’s skullduggery and in effect acquiesced to it.
Again, insurance would be insuring the bank against its own misbehaviour in not preventing the home purchase going ahead under the circumstances. One wonders whether such insurance, paying out to a bank for its own failings, would be valid.
Piška concludes: “if conveyancers undertake the relevant searches and ask pertinent questions when something appears odd or unusual, banks will not have any imputed notice of any bankruptcy proceedings or wrongdoing, and unless the conveyancer knows of any reason why the bank would not be able to rely on the defence (such as dishonesty on the part of the bank) then they will not have acted negligently”. Thus, no indemnity insurance would be required.
• Radio 4’s You and Yours has done a piece on this subject, here on iPlayer
The Council fo Mortgage Lenders Handbook notes at 5.16.3:
If you are aware that the title to the property is subject to a deed of gift or a transaction at an apparent undervalue completed within five years of the proposed mortgage then you must be satisfied that we will acquire our interest in good faith and will be protected under the provisions of the Insolvency (No 2) Act 1994 against our security being set aside. If you are unable to give an unqualified certificate of title, you must arrange indemnity insurance (see section 9)
Section 9.1 of the CML Handbook says:
You must effect an indemnity insurance policy whenever the Lenders’ Handbook identifies that this is an acceptable or required course to us to ensure that the property has a good and marketable title at completion.